The Two Most Important Questions For Investors

Specific Answers Can Have Positive Impact On Net Worth

Weekends are a good time to address areas of vulnerability in your investment
strategy. Many investors toss and turn at night worrying about wealth-destroying
bear markets or opportunities they may miss for their uninvested cash, which
is nature's way of pointing out vulnerabilities. When testing your current
approach to the markets, it is helpful to look at extreme outcomes. If you
can handle the extremes, then you can handle almost anything in between. Therefore,
this weekend ask yourself:

Do I have specific plans in place to handle these extreme investment
cases?

Case A: stocks rise an additional 91% over the next three years
as they did during the final leg of the dot-com bubble (1997-2000).

Case B: stocks drop over 50% as they did in the 2000-2002 and
2007-2009 bear markets.

Where Are We Now?

In this article, we will show the monetary importance of case A and case B,
and evaluate the present day market in relation to both cases. We'll wrap it
up with a look at the most recent read of the fundamentals/geopolitical events
and how all this impacts our current investment allocation.

Longer Than Rational Analysis Would Suggest

How could stocks possibly rise 91% between 2014 and 2016 with valuations already
stretched? That is a rational question and one that was being asked in 1997.
From a contingency planning perspective, it is best to always keep an open
mind about upside and downside potential. The S&P 500's recent breakout
from a 13-year consolidation pattern, described here,
is another reason to keep an open mind about hard-to-comprehend gains.

Bull Markets Are Followed By Bear Markets

During a bear market, investors start to believe that stocks will never go
up again. Conversely, the longer a bull market lasts, the harder it is to comprehend
that a bear market will come at some point. When the next bear market begins
is highly uncertain, but we know with 100% certainty that another bear market
will eventually rear its ugly head. If we know a bear market is in our investment
future, it is prudent to have specific plans in place.

The Math Says This Is An Important Topic

The left side of the table below shows pre-bear market portfolio values.
The right side shows what happens after a 55% bear market is done with your
account.

The left side of the table below shows pre-last stage of a bull market portfolio
values. The right side shows what happens if you capture a euphoric and irrational
91% push higher. If the bullish 91% gain scenario were to play out, many would
undoubtedly be underinvested. We reviewed the possible negative impact of being
underinvested during the final stages of a bull market on January
16.

Does 2014 Look Like The Bear Market Case?

Before we can answer the question above, we need to use a few common tools
to define what a bearish period looks like. In The
Best 2014 Investment Advice, we highlighted the benefits of evaluating
hard evidence in hand rather than trying to play the predicting the future
game. Charts are a mechanism to monitor the aggregate interpretation of the
fundamental data, which is what sets asset prices. When the aggregate opinion
is "net bullish", stocks tend to rise and trends are bullish. Conversely, when
the aggregate opinion is "net bearish", stocks tend to drop and trends are
noticeably bearish. What did the observable evidence say during the S&P
500's 91% gain from 1997 to 2000? As you can see in the chart below, the evidence
told us the aggregate interpretation of the fundamentals was "net bullish".
The chart points out three bullish tendencies that are typically present during
periods where the odds are in our favor.

What Does A Bearish Period Look Like?

To improve the odds of protecting our accounts during unfavorable periods,
we must first define what a bearish period looks like. The chart below shows
the same three concepts, but this time in a bear market context, where the
aggregate read of the fundamentals is pessimistic.

How Does 2014 Look?

The chart below shows the same three concepts as of the close on Thursday,
February 20, 2014. You do not need to have any experience with technical analysis
to see the present day looks nothing like a bear market and very much like
a bull market. Are there reasons to believe the chart below could morph into
a bearish look over time? Yes, we outlined three of them on February
20.

Latest Fundamental Data

Friday's economic calendar was light with a 10:00 am EST housing report being
the headliner. The report continued a concerning trend of relatively weak economic
reports. From MarketWatch:

Sales of existing homes fell 5.1% in January to a seasonally adjusted
annual rate of 4.62 million, the slowest pace since July 2012, the National
Association of Realtors reported Friday. Sales have trended down since
the summer, hit by declining affordability and low inventory. Unusually
poor weather may have also a played a role in January's drop, NAR said.
Economists polled by MarketWatch had expected a January sales rate of 4.65
million, compared with a December rate of 4.87 million. The median sales
price of used homes hit $188,900 in January, up 10.7% from the year-earlier
period, supported by low inventory.

You Can Build A System

Regular readers know the system we use to address both case A and case B is
the market
model. If you are interested in learning more about converting observable
evidence into an implementable risk-management system, Tired
Of Missing Rallies? 4 Ways To Improve Your Game explains the basic concepts.
Are using the 50-day and 200-day a foolproof way to monitor the markets? No,
in fact, there is no such thing as a foolproof method to monitor the markets.
However, the 50-day and 200-day do add value and they can improve our odds
of success. Indicator and method redundancy can be used to diversify your system.
For example, this flow
diagram shows numerous inputs to one of our submodels.

Investment Implications - Overseas Stress Receding

While many Americans have been distracted with the Olympics, the recent bloodshed
in the Ukraine has not escaped the eye of investors. Friday brought some much-needed
good news. From Bloomberg:

Ukrainian protesters agreed to an offer from President Viktor Yanukovych
to hold early presidential elections by December to halt a deadly three-month
political crisis. Oleksiy Haran, a member of the demonstrators' Maidan
Council, said by phone that the protesters "gave a mandate" to the opposition
to sign the deal, which includes a new government and a return to the 2004
constitution within 48 hours, a step that would curb Yanukovych's powers.
European Union foreign ministers worked all night in Kiev to broker a peace
plan.

The aggregate read of all the fundamentals includes earnings, employment,
housing, manufacturing, monetary policy, and fiscal policy. The 2014 chart
in this article has a bullish look, which tells us the current aggregate interpretation
of the fundamentals is bullish. Therefore, a growth-oriented allocation consisting
of stocks (SPY) and leading sectors (QQQ) remains prudent. On February
20, we noted the S&P 500 has made little progress over the past eight
weeks, which tells us economic conviction from the bulls is waning. Therefore,
some risk-balancing bonds (TLT) and a larger than normal stash of cash are
still on the books. Going forward, the observable evidence will guide us, if
we are willing to monitor it in a disciplined and unbiased manner.

Chris Ciovacco is the Chief Investment Officer for Ciovacco
Capital Management, LLC. More on the web at www.ciovaccocapital.com.

All material presented herein is believed to be reliable
but we cannot attest to its accuracy. Investment recommendations may change
and readers are urged to check with their investment counselors and tax advisors
before making any investment decisions. Opinions expressed in these reports
may change without prior notice. This memorandum is based on information available
to the public. No representation is made that it is accurate or complete. This
memorandum is not an offer to buy or sell or a solicitation of an offer to
buy or sell the securities mentioned. The investments discussed or recommended
in this report may be unsuitable for investors depending on their specific
investment objectives and financial position. Past performance is not necessarily
a guide to future performance. The price or value of the investments to which
this report relates, either directly or indirectly, may fall or rise against
the interest of investors. All prices and yields contained in this report are
subject to change without notice. This information is based on hypothetical
assumptions and is intended for illustrative purposes only. THERE ARE NO WARRANTIES,
EXPRESSED OR IMPLIED, AS TO ACCURACY, COMPLETENESS, OR RESULTS OBTAINED FROM
ANY INFORMATION CONTAINED IN THIS ARTICLE.

Ciovacco Capital Management, LLC is an independent money
management firm based in Atlanta, Georgia. CCM helps individual investors and
businesses, large & small; achieve improved investment results via research
and globally diversified investment portfolios. Since we are a fee-based firm,
our only objective is to help you protect and grow your assets. Our long-term,
theme-oriented, buy-and-hold approach allows for portfolio rebalancing from
time to time to adjust to new opportunities or changing market conditions.